What's the Difference Between a Law Firm's Bank Account and The Lawyer’s Wallet?
A law firm is a business; as such, it's important to remember that it needs to be run like a business - which means ensuring your personal finances are kept separate from the business finances. This distinction is essential because if you start commingling the two, it will become difficult to track where the money is coming from and going. This can lead to problems down the line, both for you personally and for the law firm. So, keep things separate and organized from the start to avoid any issues in the future.
The best way to do that is by having different accounts for each, especially regarding expenses and credit cards. That way, you can ensure that business expenses are only coming out of the business account and personal expenses are only coming out of the personal account. Having different accounts will help you stay organized and avoid any mix-ups.
As professional accountants combing through the records, we sometimes see personal expenses booked into the business account. Some of the places we see a "gray" area for costs:
That means your business account should only be used to cover legitimate business expenses. That includes things like meals and entertainment. Entertainment is no longer deductible, and meals are only deducted at 50% (covering the meal for your guest, which should be a client or a potential one).
While I am thrilled you bought beautiful Gucci shoes because you've earned enough money to pay for them, you cannot write them off in your business books. There is only one place on the books for the shoes except for distributions. In my over 25 years of doing this work, I. have many stories of clients trying to get personal transactions pushed through the business. Some crazy ones too! No, your haircut is not deductible. Your pool cleaner is also not deductible. The suits you wear to court are not deductible. They are. not a uniform unless you have the business branding on them. If the item is used in business, it is deductible.
Owners or partner distribution
These transactions that don't belong in your business should be booked to the distribution account and will be taxable personally. It's considered an income event for the owner of the company.
The Audit Story
The IRS frowns upon commingling personal and business expenses. I sat through an audit where my contractor client had used his personal credit card for business purposes. He was trying to rack up points to travel during the winter. The auditor asked for copies of the bills and credit card statements where the items were charged. The client had reimbursed himself for these expenses from the business checking account.
This client's personal credit card expenses were not for small amounts. They included truck repairs, which the auditor disallowed. There needed to be more detangling necessary to separate business from personal. Additionally, the auditor dug even deeper into the records. This commingling was not an inexpensive mistake on behalf of my client, as the auditor removed them as expenses for the business. It cost the firm over $20,000 in legitimate expenses that were disallowed.
I share this story to help prevent anyone from having to go through the same terrible experience. Even though the client had the receipts to prove that these were business expenses, the auditor still discounted them from the records because they were paid on a personal credit card.
To prevent commingling:
- Make sure you use a dedicated business credit card for your expenses.
- If your business is new and you still need a business credit card, try getting a second personal credit card and use one credit card for business and one for personal expenses.
- Keep them entirely separate.
What if you have employees that purchase on your business's behalf? That's simple, and there are a couple of options:
You can designate a specific amount your employees can use with an expense card. You can track their expenses and limit how much they can spend, so you always have control.
There's an even better reason to keep your personal and business finances separate: if you use a personal credit card for business expenses, you might miss essential deductions that could lower your taxes.
As you can see, it's essential to maintain good accounting records. No one wants to pay more in taxes than they have to. Finding a good accountant is your key to success. If you are looking for an expert, you have landed in the right place. You are just one contact form away from organized books!